Fall in Price of WTI Crude Oil

 

 Audio Version Given Below

 

 

On the morning of 21st April 2020 one of the messages I received was “WTI Crude Oil Trading in Negative”. In this article I will try to explain why WTI crude oil price fell to below zero level for the first time in history.

Crude Oil and Benchmarks

Crude oil is the yellowish- black fossil fuel that forms basis of fuels like Jet Fuel, Gasoline (Petrol), Diesel, LPG, Kerosene and other fuels and petroleum products. Being such an important asset, in modern times it is also referred to as ‘Black Gold’.

There are many blends of crude oil available worldwide depending on the location of extraction and the sulphur content present in the oil. Lesser the sulphur content, higher the quality. If it is less than 0.5%, it is called as Sweet, else it is Sour.

Here I will discuss a few major ones that are considered as Benchmarks for all blends extracted in and around that particular area. These benchmarks help the buyer to decide how much money should be paid for a certain quality of oil.

Brent Crude: Extracted from: North Sea

Comprises of: Brent Blend, Ekofisk Crude, Forties Crude, Oseberg Crude.

Sulphur content: 0.37% (Sweet)

Ideal for: Gasoline (Petrol) and Diesel

Transported by Sea

Benchmark for: Oils in Atlantic Basin

Dubai Crude: Extracted from Dubai

Sulphur Content: More than 0.5% (Sour)

Ideal for: High-Quality Diesel, Kerosene

Benchmark for: Oils in Persian Gulf area

WTI Crude (Western Texas Intermediate Crude): Extracted from Oil wells in the U.S.

Sulphur Content: 0.24% (Sweet)

Ideal for: Gasoline

Transported by pipes to Cushing, Oklahoma state of US

Benchmark for: Oil produced in the US

  

Crude Oil Contracts

We all know, Crude Oil is an extremely volatile commodity. Its price fluctuates on a daily basis. So, in order to safeguard against losses due to price fluctuations, oil is traded in Future Contracts. In simple words, the price of crude oil per barrel to be sold in future is pre-determined between the buyer and seller. These contracts are traded in Derivatives Market like any stock.

On April 20^th 2020

On 20^th April 2020, the May Future Contracts for WTI Crude showed a drastic decline and fell at the level of -$37 per barrel for the first time in history. Though the contracts for June were still trading at $20 per barrel.

What did this mean: In simple words, it means that the WTI Crude Oil sellers were willing to pay $37 per barrel to the buyers so that they purchase the oil.

Reason: This is because of lockdowns in most of the countries due to the ongoing pandemic which in turn has reduced overall demand for Crude Oil. For example:

The aircraft movement is restricted, so Jet fuel demand is less. The vehicular movement is restricted, so Petrol and Diesel is less. Factories have either been shut down or are working on highly reduced capacity, so the demand for Fuel oil used in running machinery is less.

Even though as per deal between OPEC+ countries on 13^th April 2020, the oil output was cut by 9.7 Million Barrels Per Day to stabilize the falling crude oil price, still the oil prices of crude went down.

Especially, in case of WTI crude, even with the decreased supply, the sellers did not have any capacity to store the oil, hence it was trading in negative.

However, it should be noted that the fall in price below zero, was only for the May 2020 Futures of WTI crude. For June 2020 Futures, the WTI crude was trading at $20.43 per barrel. It means that the investors feel that as lockdowns around the world ease in future, the demand of oil will increase.

Even the Brent crude for May 2020 Futures was trading around $16 per barrel. Its price has come down too but not as much as WTI crude.

Position for India

The overall oil import bill for India has come down in the previous few months. This is due to the overall decrease in prices of crude oil. It is important to understand that the incidence of WTI Benchmark falling below zero on 20^th April 2020 had no effect on India. As per Petroleum Planning and Analysis Cell (PPAC) Govt. of India, the crude oil basket for India on 20^th April 2020 stood at $20.42 per barrel, being the average of Dubai, Oman and Brent Crude.

Strategic Petroleum Reserves: Most of the countries are filling their Strategic Petroleum Reserves (SPR) to take the opportunity of this fall in the overall price of crude oil. SPR is used as an emergency supply of crude oil. As per India’s Integrated Energy Policy 2006, it is recommended to have 90 days of oil imports to be maintained as SPR. The SPR is maintained by a PSU named Indian Strategic Petroleum Reserve Limited (ISPRL). The reserves are located in Vishakhapatnam, Mangaluru and Pedur, with a combined capacity of 5.33 Million Metric Tonnes (i.e. 39 Million Barrels).
This capacity will be sufficient for 9 days of imports, as per the data available for 2019-20 on PPAC website. The MD of ISPRL announced on 27^th April 2020 that SPR will be filled by the third week of May.

To further augument the capacity of SPR as per policy, Govt of India has given in-principle approval for creating additional capacity of 6.5 Million Metric Tonnes.

 

Effect on common people: Even though since the past 2 months the oil prices have come down drastically due to excessive supply still, the fuel prices have not decreased proportionately. This is because the Government is using the benefit of lower import bill to make up for the financial losses it is sustaining due to lockdown.

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